Ken Kam's Best Ideas Blog

When I started Marketocracy I thought I'd find lots of people like me, with firsthand experience in an industry that also had a passion for investing. And I did; but I also found lots of skilled investors that had different approaches to investing than mine. That has been one of the amazing surprises about our investment process.

Personally, I do fundamental analysis and like to invest in stocks that I think have a good chance of at least doubling within 2 years. Why a double? If a stock doesn't have at least a chance of doubling, it probably isn't worth the time and effort needed to research and follow it.

I try to identify two or three things that if they happen could drive a double in the stock's price. I call those nuggets and I call this approach prospecting for nuggets. A nugget is more valuable the higher the probability it will occur and if it is undiscovered.

Look where you have an advantage over most of the market. If you look in places that have already been picked over by lots of people, you probably won't find many nuggets. You need to look where most people aren't looking or at things that most people aren't looking at. A good place to start is in the industry and with the companies that you have firsthand experience or knowledge about. Often, you'll know more about new products, customer acceptance, and the impact on the market sooner than Wall. St. analysts do.

Develop your nugget hypothesis. A framework I find useful is to identify the key drivers of value for a company. Generally those drivers begin with the components of earnings and earnings growth, e.g., sales, sales growth, and margins. Next identify the events that could change those drivers significantly. For example, if the FDA approves a new drug it will provide a new revenue stream worth X, if an existing product gains access to a large new market revenue will increase by Y, and if a competitor is eliminated it will reduce alternatives and can lead to higher margins.

Next, you need to evaluate and assess your nugget hypothesis: will it have the expected impact and what is the probability that it will occur. I like to develop a list of questions that help me understand the situation better and help me make that assessment. If I have firsthand experience I may be able to answer many of the questions myself. More often it really helps to know the right questions to ask and of whom to ask the questions. For instance, Elan is one of the stocks we wrote about in this issue of Marketscope. One of the critical questions is whether or not Elan's drug, Tysabri is effective in monotherapy. Ideally, I'd like to be able to ask that question of physicians or patients that have used Tysabri to treat MS and can provide comparison to existing treatments. I don't have that personal experience but by finding the right people to pose the question to I can make a good assessment of Tysabri and Elan.

There is a parable of the blind men, each holding a different part of an elephant, each with a different perspective of the same animal based on their experience. One man feels the trunk and declares, "it's a snake!" Another feels the leg and says, "it's a tree." Still another touches a ear and thinks it's a fan. And the one that grabs the tail thinks it's a rope. Few people see enough aspects of a company to put the entire story together themselves.

Marketocracy has developed a community of investors with firsthand experience in almost every area of the economy. Our goal is to tap that vast network of expertise and insight, to prospect for nuggets, and generate good investment advice.